Multi Currency Economic Cycles


Multi Currency investing is affected by economic cycles just as our lives are affected by the seasons. Right now both global and the US economies have entered a normal down phase.

This cycle may be a bit harsher than the last few downturns because it has been delayed by global government interference, in part via global excess liquidity.

Times like this (when so many investments are dropping) can seem scary. Actually they are good for investors who have a Birds Eye Vue and are looking at the big picture and are searching for value.

These downturns are a seasonal cleansing which bring shares, real estate and bond prices back to reality.

However, this puts the US dollar in a similar position to the British Pound when it was crushed after WWI.

During the war, British companies and investments worldwide had to be sold to make artillery shells and other items unproductive in an insane world. Soon the pound, which had ruled and stabilized the world for centuries, was no longer worth a pound. Through the 1920s, the British tried to hold the pound at $4.86. The government raised interest rates, trying to attract foreign investment.

The effects of this on the domestic economy were horrible. Growth slowed, then stopped altogether. Unemployment rose. Then the global depression of the late 20s struck another blow. In 1931, the English government allowed the pound to float and it has never seen $4.86 again.

History repeats and the U.S. dollar is in the similar position today. The dollar is falling but the Federal Reserve Bank hesitates to raise interest rates to strengthen the dollar because it fears that high borrowing costs will harm business and the domestic economy. The Fed dropped interest rates instead.

This adds huge pressure on the greenback. In previous times of fundamental weakness, the greenback was assisted either by a high and rising interest rate or a strong showing on Wall Street. These factors attracted foreign investors and helped prop the currency up.

Now the US is in the normal down phase of its economic cycle at the same time the global economy faces slower growth.

During the down economic cycle corporate earnings slow, which typically pushes share prices down.

So US share prices do not seem especially attractive to foreign investors who could bolster the buck with their share investments. Actually US shares are offering greater value now but by comparison their pattern may not be of the type that will attract a groundswell of investors needed to support the dollar.

This makes a multi currency portfolio even more important. The US dollar has dropped a lot and may be at a plateau or even in a position of modest strength.

Yet be careful of investing in overseas shares. US shares are starting to make sense now as do emerging bonds.

Jyske Bank explains why in a recent update that says:

In recent years earnings growth has been unrealistically high seen in a long-term perspective. In 2008, the return on the asset classes will generally fall. This is not only true for equities but also for other asset classes.

We maintain our neutral weight of equities. Slower growth is still offset by a sensible valuation and compared to the alternatives equities are still an attractive asset class. The combination of very high global growth in recent years and a considerable slowdown in US growth requires a highly flexible monetary policy.

We maintain our neutral weight recommendation for equities. The equity markets have in recent months been knocked about somewhat. The fundamentals are still generally in fine shape although falling growth and fear of recession in the US make investors jittery. The low P/E level relative to the interest-rate level makes equities more attractive than bonds. Since earnings growth is on the decline, it is justifiable to assume that the total return on equities in 2008 will be a function of lower earnings growth and some multiple expansion. For 2008, we thus expect a return which is somewhat lower than in recent years but which is close to the long-term average of 5-10%.

We raise US equities to overweight. The dollar has weakened markedly in recent quarters, and as a minimum we expect stabilization in the coming months. During periods with rising uncertainty and lower growth, the equity markets need considerable flexibility in the monetary policy. Although it is not our fundamental view that the US economy will be in recession, we trust that if this were to happen the Fed has shown during periods with negative growth that real interest rates close to zero or even in negative territory are not unusual. This will be a supportive factor.

We maintain our underweight of European equities. European equities are undervalued compared to

US equities, but earnings estimates are on the decline. And given the recent statements from the ECB about the future monetary policy, lower earnings growth will not be shouldered by expectations of lower interest rates. A delayed effect of the low USD and the sharply rising energy prices are also a possibility just as the sub-prime problems in the US have turned out to be a European challenge.

We revise down Japanese equities to neutral weight from overweight. The way out of the economic problems for Japan has turned out longer than first assumed. Prospects for the labour market, the banks and the property market are on the right track. But it will take a while. And in a period where flexibility in the monetary policy is needed Japan is not the most obvious equity country. Japanese interest rates will not be raised in earnest until deflation is a thing of the past. A rise in interest rates will be seen as positive by the equity market. But this is not on the cards at the beginning of 2008.

We only revise down the recommendation to neutral due to tactical considerations. Foreign investors have in 2007 changed their weight from overweight to underweight, and such a movement may sometimes leave a price vacuum.

Emerging-market equities in the Far East, Latin America and Eastern Europe have seen sharp price increases in 2007 even though there has been a correction in recent months. The equities are thus significantly overvalued and are today trading at P/E levels similar to those of developed-market equities. However, the development of earnings is still positive, and on this background we maintain our neutral weight compared with developed-market equities. As long as we do not see a major downturn in the markets, emerging-market equities will outperform developed-market equities, but they may also be hit very hard if the turbulence aggravates. We maintain our neutral weight.

We maintain our underweight of developed-market bonds. Long-term yields are still low. As we see it, notably US interest rates are below neutral level. Developed-market bonds are no longer so attractive. We expect a rise in long-term yields when the turbulence has abated again.

We overweight high-yielding bonds. Within the asset class, we recommend neutral weight for emerging-market and corporate bonds. We have previously been concerned about the very narrow credit spreads, but due to the strong widening of spreads, high-yielding bonds have become more attractive. On the other hand, the spread widening also reflects an increased risk and the credit crisis is definitely not over yet. But fundamentally, we still assess that both emerging-market and corporate bonds look strong.

Jyske’s overall asset class recommendation for a balanced investor is:

Developed-market equities 36%

Emerging-market equities 4%

Developed-market bonds 45%

High-yielding bonds 15%

Emerging-market bonds 15%

Developed Corporate bonds 7.5%

Cash 0%

Aggressive investors would have more equities and emerging investments. Income oriented investors more bonds.

Times when the economic cycle heads south can be frightening. Yet they are no more than winter hiatus natures way of cleansing so new growth can emerge. This is a time to prepare the soil and be ready to plant seeds for the next wave of even higher growth.

Do not overextend now. Look for bargains instead. This is a good time for value oriented investors.

Until next message, I hope that your orientation always brings you good value.

Gary

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